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Don’t Count Out the Middleman

By Ari Charney on April 1, 2013

Okay, I’ll admit it: I’m a bit of a worrier. Indeed, sometimes I feel like the topmost crenellation in the market’s proverbial wall of worry. But as long as the Federal Reserve continues to flood the economy with liquidity, the market will inexorably head higher.

However, I’m less confident about the global economy, whose lackluster performance ultimately flows through to the companies that comprise the stock market. But if you’re more sanguine than me about the prospects of both the market and the global economy, then shares of third-party logistics provider Expeditors International of Washington (NSDQ: EXPD) finally offer a compelling entry point.

This high-quality mid-cap stock trades near $35.30, down almost 26 percent from its 52-week high. In fact, Expeditors’ shares haven’t enjoyed a positive calendar year of stock market performance since 2010, when shares rocketed 58.2 percent higher from the prior year. The stock is down about 37 percent since the stock’s high in late 2010, and now trades at prices last seen during the 2008-09 Great Recession–even though 2012 earnings per share were 41 percent higher than 2009.

The major culprit in the stock’s performance is the slowing global economy, particularly its dampening effect on the key US/Asia trade lane. As an international freight forwarder, Expeditors is essentially a toll taker of global trade: It buys cargo space on airlines and ocean-going vessels in bulk, and then sells that space to manufacturers and shippers of consumer goods. It also handles ancillary services such as customs brokerage.

Airfreight services accounted for 43.5 percent of the $5.98 billion in 2012 revenue, while ocean freight and services accounted for 33 percent of revenue, with customs brokerage coming in at 23.5 percent. In fact, the company has its highest operating margins with the latter segment, roughly 55.1 percent versus 23.7 percent and 21.9 percent for airfreight and ocean freight, respectively.

Not only has trade slackened in recent years, but the nature of the goods being shipped has also changed. In particular, the slimming effects of technological innovation have reduced the size of everything from computers to televisions. And the corresponding decline in the weight of goods being shipped has eroded Expeditors’ bottom line. As such, the company has recently had difficulty replicating the extraordinary growth investors had come to expect from the past 10 years, when the stock nearly tripled its market cap.

Revenue growth has slowed markedly over the past two years, while earnings per share fell 12 percent in 2012 versus the prior year. Even so, analysts forecast a 14.6 percent rise in earnings per share this year, and a 13.9 percent increase the following year–hardly a disaster. And the consensus estimate for EPS growth over the next five years is just under 9 percent annualized.

Nevertheless, analyst opinion on the stock is an almost even split, with 11 rating Expeditors a “buy,” 11 rating it a “hold,” and one “sell.” The consensus 12-month price target is $44.71, which would mean a nearly 27 percent gain from current prices.

Still, Expeditors has clearly become more of a cyclical play than the secular growth story of the past decade. But once investors finally adjust to this new reality, they’ll stop pushing share prices lower.

In the meantime, Expeditors’ seasoned management team eschews Wall Street’s shortsighted emphasis on quarterly performance, instead running the company for the long term. At the height of the downturn, for example, they famously avoided layoffs in order to keep the company’s team in place for the eventual recovery.

Expeditors’ non-asset-based model also helps preserve margins during downturns, while also enabling it to produce strong returns on invested capital (ROIC). In fact, the company has produced an average ROIC of 19.5 percent over the past five years.

Though the freight-forwarding industry is highly fragmented, it’s unclear to what extent Expeditors might pursue a roll-up strategy. That’s because management has been largely focused on growing organically, rather than by acquisition. But slower growth prospects and the low return earned by the high level of cash on its balance sheet could conceivably compel it to do so.

Expeditors boasts a rock-solid balance sheet, with $1.3 billion in cash at year-end and no long-term debt. And the company generates strong free cash flows, averaging $351.7 million over the past three years. So it has plenty of financial flexibility to make strategic acquisitions.

For now, Expeditors is working toward further enhancing its high level of customer service and refining its operational efficiency through investments in training and information technology.

Management might be disdainful of Wall Street, but it still engages in shareholder-friendly practices. The $7.3 billion company bought back $302 million worth of stock in 2012, and its $0.28 quarterly dividend translates into a 1.6 percent yield at current prices.

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